European watchdog savages ratings agencies

Major ratings agencies are under attack from the European market watchdog, which claims to have found “deficiencies" in the way they determine sovereign debt ratings.

In a new report, the Paris-based European Securities and Markets Authority (ESMA) said its investigation into Fitch, Moody’s and Standard & Poor’s had revealed issues in the sovereign rating processes which “could pose risks to the quality, independence and integrity of the ratings".

ESMA’s investigation took place between February and October this year.

In its report, ESMA warned rating agencies relied too heavily on junior or newly hired staff to determine sovereign ratings and had “inadequate" controls in place to ensure market sensitive information was kept confidential until it was released publicly.

In addition, the watchdog said its investigation had raised issues around conflict of interest.

It said the involvement of senior management or even board members in rating decisions could “compromise" their independence, and increase the possibility of ratings being influenced by commercial incentives.

“The impact which changes in these ratings can have on financial markets, and sovereign states, can be significant," ESMA chairman Steven Maijoor said. “Therefore, it is imperative that users can have confidence that the [credit ratings agencies] have adequate systems and controls in place to ensure that ratings are rigorous, free from conflicts of interest and timely,"

Ratings agencies have sparked outrage in European capitals in recent years after they downgraded the credit ratings of countries such as Italy, Spain, Portugal and Greece, citing concerns about their hefty debt burdens.

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European politicians believe these downgrades fanned the region’s debt crisis by pushing borrowing costs for these countries sharply higher.

Ratings agencies were also attacked during the 2008 financial crisis after they assigned ultra-safe AAA ratings to complex financial products that resulted in large losses for many US and European banks and insurance companies.

ESMA has yet to determine whether the firms had breached credit ratings agency regulation, which could result in them paying a fine or even forfeiting their licence.

In the meantime, ratings agencies are under pressure to quickly address the issues identified in the report.

The report was released just days after Standard & Poor’s moved to strip the Netherlands of its top AAA rating, leaving only 10 countries worldwide, including Australia, with the coveted AAA rating.

The Netherlands’ downgrade means there are only three countries in the euro zone with an AAA rating: Finland, Luxembourg and Germany. Two years ago, six euro zone countries boasted the top credit rating.

Last month, France also suffered a downgrade by Standard & Poor’s, which cut the country’s credit rating from AA+ to AA. S&P was the first ratings agency to strip France of its AAA rating in January last year, although both Moody’s and Fitch have since followed suit.

Paris hit back at its latest downgrade, with French Finance Minister Pierre Moscovici saying he “regrets the inaccurate and critical judgments made by the rating agency Standard and Poor’s".